Nine ways to find hidden savings in your outsourcing invoice

Mistakes happen. Situations change. Yet very few outsourcing customers regularly check their outsourcing invoices against their original contracts on a regular basis. And that means they may be leaving thousands -- or millions -- on the table, says outsourcing consultants Adam Strichman and Mark Ruckman.

An outsourcing audit, especially these days when every dollar counts, can be a good investment.

"In addition to reviewing invoices for errors and SLAs and the typical stuff, there are lots of rocks to overturn...areas where the vendor may not be living up to its responsibilities, or where they may be making financial errors," says Strichman, founder of Richmond, Va.-based outsourcing consultancy Sanda Partners. "The goal is to find money you may be owed or services the vendor is not doing -- or doing right -- to use as leverage for other negotiations."

Outsourcing invoices can be complex -- and dozens of pages long. What's more, there's often only one person on the provider side and one person on the client side who understands the details. No one asks, "Does the contract really allow them to charge for that?" or "Is that line item even relevant anymore?" Seemingly insignificant line items can add up over time.

Full-blown contract audits by a third party can be expensive, but it is possible to conduct your own audits internally. Reserve a conference room, have the person most familiar with the contract explain each line item to an IT executive unfamiliar with the invoice. "After his or her shock about the complexity of the invoice, you will find 10 percent of the line items will drive a lot of discussion," Strichman says, "and 5 percent of them can't be explained at all."

Such an effort can yield at least 1 percent of the total contract value in savings for each year the invoices have gone unchecked, says Strichman. At a minimum it will drive discussion with the vendor about items which may not be necessary, whether the charges are correct or not. Ruckman, who works as an independent outsourcing consultant in conjunction with Sanda partners has seen clients save anywhere from a few hundred thousand dollars to over six million per year.

When you approach the vendor about audit findings, don't expect to be greeted with open arms. "The providers can be defensive. Some are trying to protect their base charges and others didn't realize these billing issues had evolved over the past several years," says Ruckman. "But in the end the providers all come around."

Here are nine common areas for errors in outsourcing invoices.

1. Leased Space

If you are renting space to your provider, double check their leasing obligations and responsibilities. Many times the customer continues performing certain data center duties, unaware that the provider is now liable for them. The potential cost savings increase with the size of the facility.

2. Secret Offshore Staff

It's an open secret that most outsourcing providers have been shifting more of their workload to lower cost location. But they may be quietly offshoring your work -- particularly non-client facing roles -- and pocketing savings as their profit.

You may be paying $100,000 a year for a database administrator per your IT services contract while your vendor has been sourcing that work in India for $30,000 annually.

Request a list of all full- and part-time staff working on your account outside the U.S. and review past invoices to figure out if rates decreased with additional offshoring. Review your contract for language dealing with use of offshore labor.

3. Cost-of-Living Adjustments (COLA)

COLA contract provisions call for an adjustment to the fees to reflect inflation. Improper inflation calculations are rare, says Strichman, but they can have a huge impact when discovered.

Vendors are adept at increasing their costs each year along with inflation, but in 2009 COLA actually went down for most outsourcing customers. Did their fees? Confirm that the COLA is calculated correctly and your monthly invoice moved in tandem with the adjustment. If you're renting space to your provider, the lease normally includes a COLA clause. Make sure that you actually increased the rent each year along with inflation. Thousands could be hiding here.

4. Temporary Labor

"The most common areas we find include improper use of contractual labor rates," Strichman says. "Hours calculations are usually correct, the problem is whether or not those hours are actually chargeable for the work performed per the contract, and whether or not the proper rates were correctly applied to the labor in question."

Review past invoices and compare contract labor rates and invoiced rates -- and don't forget to apply COLA to the rates. There are two kinds of temporary project staff from a provider: short termers that work one to six months and long termers working six months or more. Were you charged short-term rates when a person was working on a long term project?

The cost of project staff is much higher than hiring a full time employee. And the provider charges you that salary and benefit cost plus their margin, which can be from 35 to 75 percent, Ruckman says. Short term workers are fine for truly short-term needs, but they can become a long-term resource if a project drags out. You don't want to be gouged for full-time work.

In addition, always compare the provider's temp rates to those offered by local staffing agencies. "We have seen many cases where a client can save 20 to 30 percent for the same skills," Ruckman say.

5. N-1 for Hardware and Software

Chances are your contract contains a clause stating the outsourcing provider must keep hardware and software at a defined level -- likely N-1, the industry term for one version prior to the newest one. "Customers don't want hardware nor software that is too old, because the older it is the more is breaks down and higher the expense to maintain," says Ruckman. "Customers also don't want all hardware and software to be the latest and greatest, because the new stuff hasn't been tested in the real world."

The problem is that most providers don't maintain software at N-2 or N-3, let the N-1 you are paying them to maintain. "Eventually the customer is going to experience larger or more frequent outages or have to pay a large bill to upgrade multiple versions," Ruckman says. "Rarely is the provider at the required level and reaching compliance can be expensive and, thus, a bargaining chip [for the client]."

Older software and hardware can also cost you in the maintenance department (see #9 below).

6. The Responsibility Matrix

Most IT services contracts have one or more responsibility matrices. Review each responsibility to determine if the vendor is living up to it. In some cases, vendors are performing 50 percent or less of their contractual duties, says Strichman. You'll likely find responsibilities that you don't understand at all so be prepared to do some additional investigation.

7. Shelfware

An audit of software charges almost always pays off, say Strichman and Ruckman. They recently found that one outsourcing client was paying $400,000 a year for software they didn't use.

8. Pass-Through Expenses

These are additional fees the vendor charges you as they are incurred, and even they don't review them as they "pass through." Some may be subject to restrictions such as advance approval. Start with the biggest pass-along invoices and figure out what it is for, if you are using it, and what alternative exist to the product or service.

9. Hardware and Software Maintenance

Take a look at your maintenance costs to find out which you are paying and whether the vendor has been soliciting competitive bids for the work or just awarding it to itself. In many cases, you can purchase maintenance services from a third party at one-third to one-half of the price your IT service provider is charging, say Ruckman and Strichman.

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